The Gujarat High Court has delivered a significant ruling on the GST treatment of corporate guarantees furnished by holding companies for their subsidiaries, upholding the constitutional validity of Rule 28(2) of the Central Goods and Services Tax Rules, 2017, while reading down the expression “whichever is higher” in the valuation mechanism.
The bench of Justice A.S. Supehia and Justice Vaibhavi D. Nanavati has observed that GST cannot be levied under Rule 28(2) on corporate guarantees furnished before October 26, 2023, though the levy can apply from that date if such guarantees continued thereafter.
The petitions challenged the validity of Rule 28(2) of the CGST Rules, Section 15(4) of the CGST Act, and CBIC Circulars dated October 27, 2023 and July 11, 2024. The petitioners had argued that an unremunerated corporate guarantee furnished by a holding company for its subsidiary does not constitute a taxable supply of service.
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The controversy arose from the GST Department’s treatment of corporate guarantees as taxable supplies between related persons. Rule 28(2), inserted with effect from October 26, 2023, provides a specific valuation mechanism for corporate guarantees furnished by a supplier to a related recipient located in India for obtaining financing from a banking company or financial institution.
Under the rule, the value is deemed to be 1% of the amount of the guarantee per annum or the actual consideration, whichever is higher, subject to the prescribed proviso where the recipient is eligible for full input tax credit. The Court recorded that Rule 28(2) was introduced by Notification No. 52/2023 dated October 26, 2023, while the words “per annum” were subsequently inserted with effect from the same date through Notification No. 12/2024.
The petitioners questioned both the taxability of the underlying transaction and the statutory authority for prescribing a deemed valuation of 1%. They contended that Rule 28 is a machinery provision and cannot itself create a taxable event where none exists under Section 7 of the CGST Act.
A central argument before the High Court was that a corporate guarantee furnished without consideration does not satisfy the statutory ingredients of “supply”.
The petitioners argued that Section 7 requires an identifiable supply of goods or services made in the course or furtherance of business. According to them, a corporate guarantee is essentially a contingent contractual obligation and does not involve an immediate transfer or provision of a service. They maintained that nothing is actually supplied unless the guarantee is invoked and that a gratuitous guarantee does not ordinarily involve consideration, cost or commercial remuneration.
They further relied upon the distinction between the pre-GST service tax regime and the GST framework. Under the earlier regime, the Supreme Court had held in the context of corporate guarantees that service tax was not leviable in the absence of consideration. The petitioners argued, however, that the GST provisions could not be interpreted to automatically convert every corporate guarantee into a taxable service merely because the parties were related.
The petitioners also stressed that a corporate guarantee is a tripartite arrangement involving the subsidiary as principal debtor, the creditor bank and the holding company as surety. The High Court examined the contractual structure, noting the principal agreement between the subsidiary and lender, the collateral arrangement between the lender and the holding company, and the implied relationship between the holding company and subsidiary concerning indemnification.
The department on the other hand, argued that GST had deliberately expanded the taxable framework beyond the consideration-based model applicable under the erstwhile service tax regime.
According to the department, Section 7(1)(c), read with Schedule I and the relevant provisions of Schedule II, enables certain transactions between related persons to constitute supplies even without consideration. The Department therefore maintained that the absence of a monetary fee for furnishing a corporate guarantee does not by itself take the transaction outside GST.
The department also defended Rule 28(2) as a valuation mechanism framed within the statutory architecture of Section 15. The Department contended that once the transaction is recognised as a taxable supply, Parliament and the delegated rule-making authority are entitled to prescribe a special valuation mechanism for a transaction where determining the open market value may be difficult.
After examining the statutory scheme, contractual nature of guarantees and competing arguments, the High Court rejected the fundamental challenge to the levy.
The Court held that the GST regime contains a statutory framework capable of bringing corporate guarantees furnished between related persons within the taxable supply mechanism. The Court also examined the special valuation framework under Section 15 and Rule 28(2), ultimately upholding the validity of Rule 28(2) and Section 15(4).
The ruling therefore establishes an important distinction: the Court did not accept the argument that a corporate guarantee furnished without consideration is altogether outside the GST net.
While upholding Rule 28(2), the Gujarat High Court found fault with the expression “whichever is higher”.
The Court reasoned that the provision, if interpreted literally, would deny the taxpayer an effective choice between the actual consideration and the statutory 1% benchmark. According to the Court, the expression is arbitrary because it could require taxation based on the higher amount even where actual consideration is lower.
Instead of striking down the entire rule, the Court adopted the doctrine of reading down. It held that Rule 28(2) could be preserved by restricting the operation of “whichever is higher”, thereby allowing the valuation to operate on the basis of either actual consideration or the prescribed 1% benchmark.
This means that the Court has preserved the 1% mechanism but removed the mandatory requirement that the higher of the two figures must invariably be adopted.
One of the most consequential findings concerns the temporal operation of Rule 28(2).
The Court noted that several corporate guarantees involved in the batch had been executed as far back as 2012 and continued into later years. Rule 28(2), however, was introduced only on October 26, 2023. The Revenue had sought to apply the 1% valuation retrospectively or retroactively to guarantees executed before that date.
The High Court held that applying Rule 28(2) to guarantees executed before October 26, 2023 would amount to imposing a new tax burden for a period when no such valuation mechanism existed.
The Court specifically observed that the retrospective application would be harsh and unfair because taxpayers had arranged their financial affairs under the law prevailing at the relevant time. It held that imposing a 1% annual GST valuation on corporate guarantees for the period preceding October 26, 2023 would violate Articles 14 and 19(1)(g) of the Constitution.
At the same time, the Court clarified that where a corporate guarantee continued beyond October 26, 2023, GST could become applicable from that date because the taxable event would arise for the period after introduction of Rule 28(2).
The judgment also dealt with corporate guarantees furnished in favour of subsidiaries located outside India.
The Department had issued a show cause notice demanding IGST of approximately ₹96.46 lakh, based on a deemed value of about ₹5.36 crore, concerning guarantees furnished for foreign subsidiaries. The Court found that the case was covered by CBIC Circular No. 225/19/2024-GST and held that the 1% per annum valuation under Rule 28(2) would not apply to the guaranteed amount in that case. The corresponding show cause notice was consequently set aside.
The petitioners had also challenged the CBIC Circulars dated October 27, 2023 and July 11, 2024 on the ground that the Board had exceeded its administrative powers by effectively determining the taxability and valuation of corporate guarantees.
The High Court did not invalidate the circulars in their entirety. Instead, it held that circulars merely operationalise and clarify the statutory framework and cannot independently create a levy. Since the Court had interpreted Rule 28(2) and read down “whichever is higher”, the circulars had to conform to that interpretation.
The Court consequently set aside the impugned circulars to the extent that they were contrary to the Court’s findings and directions, while leaving it open to the Revenue to issue fresh circulars or administrative instructions consistent with the judgment.
The judgment also provides significant relief concerning proceedings initiated under Section 74 of the CGST Act.
In one petition, the Department had imposed a demand and penalty of approximately ₹17.33 crore for the period from July 2017 to March 2023, alleging that the taxpayer had failed to correctly disclose the value of corporate guarantees in GSTR-1 and GSTR-3B and had thereby suppressed facts and evaded tax.
The High Court emphasised that Section 74 requires a strict showing of fraud, wilful misstatement or suppression of facts with intent to evade tax. Mere non-payment of tax arising from a bona fide interpretation of a disputed statutory provision cannot automatically amount to wilful suppression.
The Court found that the taxpayers had relied upon the provisions of the GST law and defended their position on the basis that no consideration was involved. The dispute was therefore fundamentally one of statutory interpretation. The Court found no material indicating deliberate suppression or an intention to evade tax.
The Court consequently held that the invocation of Section 74 was unsustainable. It quashed the relevant orders and show cause notices, particularly where the Department sought to invoke Section 74 in relation to corporate guarantees executed even before the GST regime.
The Gujarat High Court held that Rule 28(2) of the CGST Rules is intra vires the CGST Act and Articles 14, 19(1)(g) and 265 of the Constitution, except that the expression “whichever is higher” must be read down.
The Court further declared that GST cannot be levied under Rule 28(2) on corporate guarantees furnished before October 26, 2023. However, where such guarantees continued beyond that date, the levy would be attracted from October 26, 2023. Section 15(4) was also upheld.
The Court additionally quashed the impugned action taken by the Revenue under Section 74, directed refund of any excess GST deposited by the petitioners, while permitting adjustment of such amounts where the parties so choose.
The writ petitions were consequently allowed in part, with the directions to be implemented within three months.
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